FOGLE: Carried interest: Unfettered greed or sound economic policy?

By KEVIN FOGLE

Monday, May 13, 2013

“Of the many injustices that permeate America’s byzantine tax code, few are as outrageous as the tax rate on ‘carried interest,’” New York Times Columnist Lynn Forester de Rothschild passionately argued in an Op Ed piece about six weeks ago. Like Rothschild, President Obama agrees that carried interest taxation policy must be changed. A few weeks after his inauguration for a second term, the President said he “would push hard to get rid of loopholes such as the ‘carried interest’ tax break enjoyed by private equity and hedge fund managers.”

The man President Obama defeated at the polls last November to gain a second inauguration earned a substantial amount of his fortune from businesses that benefit from current carried interest policy. In fact, the divisive subject found its way to the forefront of last year’s presidential campaign after the Obama Administration deftly portrayed Mitt Romney as the “posterboy” for carried interest exploitation, sparking an already incendiary, yet often misunderstood national debate.

By definition, carried interest is a tax policy that allows general partners of a private investment fund to treat income as capital gains, taxable in 2013 at 20 percent, instead of personal income, taxable at a maximum of 39.6 percent in 2013. There are colorable justifications for treating carried interest as capital gains, but this essay will not repackage them. Instead, it strives to make some pithy, thought-provoking points that show that this debate is infinitely more complex than it often appears on its surface.

Of course, some pundits think the carried interest debate is easily resolved. Lynn Forester de Rothschild argued that “Eliminating the carried-interest tax rate should be an easy sell. It should play to Republicans’ supposed hatred of government handouts and to Democrats’ commitment to social justice.”

Rothchild’s opinion is characteristic of the superficial analysis that has decried carried interest policy during the past year; the same sort of analysis that decried the policy of supply-side economics decades ago, also known as “Reaganomics.” During Reagan’s presidency, it was seemingly impossible for critics to believe that the US could actually raise gross tax revenue by reducing taxes, benefitting the country as a whole.

Today, superficial analysis decries carried interest, fervently arguing that it is fundamentally unfair. But business and economics are driven by rationale and logic, not emotion. Carried interest generates massive amounts of tax revenue annually, also benefitting the country as a whole.

Let’s get one thing straight: the US is far from the only country with a friendly carried debt policy. For starters, Switzerland, Japan, New Zealand, the United Kingdom, Australia, Canada, and Ireland all employ very similar policies. In fact, many of these countries employ more welcoming carried interest policies.

If the US eliminated current carried interest policy or even significantly increased the 20 percent capital gains tax rate on carried interest, hundreds of billions of dollars in investments would likely move overseas or across our northern border each year, thereby depriving the country of billions in tax revenue and, indeed, harming the country as a whole. Even the staunchest of critics must concede that the resulting decreased tax revenues and economic activity would have a deleterious effect on the standard of living in our country.

Like supply side economics, carried interest is sound policy that often masquerades as nothing more than counterintuitive policy that begets, furthers, and feeds the unrequited greed of an elite few. Admittedly, wealth and unrestrained opulence are often repulsive both in simple everyday manifestations and for the easy access it gives its keepers to unsavory motives, devices, and manipulations.

But a superficial negative judgment of carried interest is simply misguided. Wealthy countries need wealthy people. Wealthy people need mechanisms through which to acquire wealth. In this light, carried interest is sound policy – and several of our country’s well-to-do peers across the globe are in full agreement.

Kevin C. Fogle is a 2010 graduate of Columbia University Law School. He currently works as an attorney in Montgomery County, with a particular interest in taxation law.